Annual report pursuant to Section 13 and 15(d)

Orion Office REIT, Fair Value Measures

v3.22.4
Orion Office REIT, Fair Value Measures
 12 Months Ended
Dec. 31, 2022
Fair Value Disclosures [Abstract]  
Fair Value Measures
Note 5 – Fair Value Measures
Items Measured at Fair Value on a Recurring Basis
The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2022 and 2021, aggregated by the level in the fair value hierarchy within which those instruments fall (in thousands):
Level 1 Level 2 Level 3
Balance as of December 31, 2022
Derivative assets $ —  $ 6,308  $ —  $ 6,308 
Level 1 Level 2 Level 3
Balance as of December 31, 2021
Derivative assets $ —  $ 299  $ —  $ 299 
Derivative Assets – The Company’s derivative financial instruments relate to interest rate swap agreements entered into in order to hedge interest rate volatility with respect to the Company’s borrowings under the Term Loan Facility (as defined in Note 6 – Debt, Net). The valuation of derivative instruments is determined using a discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, as well as observable market-based inputs, including interest rate curves and implied volatilities. In addition, credit valuation adjustments are incorporated into the fair values to account for the Company’s potential nonperformance risk and the performance risk of the counterparties.
Although the Company determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with those derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Company and its counterparties. However, as of December 31, 2022 and 2021, the Company assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and determined that the credit valuation adjustments are not significant to the overall valuation of the Company’s derivatives. As a result, the Company determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
Items Measured at Fair Value on a Non-Recurring Basis
Certain financial and nonfinancial assets and liabilities are measured at fair value on a non-recurring basis and are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment.
Real Estate and Other Investments – The Company performs quarterly impairment review procedures for real estate investments, and property and equipment, right of use assets and its investment in the Arch Street Joint Venture, primarily through continuous monitoring of events and changes in circumstances that could indicate the carrying value of such assets may not be recoverable.
As part of the Company’s impairment review procedures, net real estate assets representing 18 and 10 properties were deemed to be impaired during the years ended December 31, 2022 and 2021, respectively, resulting in impairment charges of $66.4 million and $49.9 million during the years ended December 31, 2022 and 2021, respectively. The impairment charges relate to adjustments to expected sales prices for certain non-core assets which have been identified by management for potential sale or management determined would not be re-leased by the existing tenant.
During the year ended December 31, 2020, the Company analyzed a unique triggering event related to one property that had a near term lease expiration, combined with a mortgage loan maturity. The estimated future undiscounted cash flows of this property indicated that carrying value was not expected to be recovered, and after estimating the fair value, an impairment charge of $18.7 million was recorded for the year ended December 31, 2020. The fair value measurement for this property was determined by applying a sales price based on market comparable sales provided by a third party. This input is categorized as level two on the valuation hierarchy. The Company also identified the impact of the COVID-19 pandemic as an impairment triggering event during the year ended December 31, 2020. However, after performing review procedures, the Company did not identify additional carrying values of properties impacted by the COVID-19 pandemic during the year ended December 31, 2020.
The following table summarizes our provisions for impairment during the periods indicated below (dollars in thousands):
Year Ended December 31,
2022 2021 2020
Number of properties 18  10  1 
Carrying value of impaired properties $ 142,748  $ 109,197  $ 29,129 
Provisions for impairment (66,359) (49,859) (18,671)
Estimated fair value $ 76,389  $ 59,338  $ 10,458 
The Company estimates fair values using Level 2 and Level 3 inputs and uses a combined income and market approach, specifically using discounted cash flow analysis and/or recent comparable sales transactions. The evaluation of real estate assets for potential impairment requires the Company’s management to exercise significant judgment and make certain key assumptions, including the following: (1) capitalization rate; (2) discount rates; (3) number of years the property will be held; (4) property operating expenses; and (5) re-leasing assumptions including number of months to re-lease, market rental revenue and required tenant improvements. There are inherent uncertainties in making these estimates such as market conditions and performance and sustainability of the Company’s tenants.
For the Company’s impairment tests for the real estate assets during the year ended December 31, 2022, the fair value measurement for 17 impaired properties was determined by applying an estimated sales price based on market data and one impaired property by applying a weighted average discount rate of 8.5% and capitalization rate of 8.0%. During the year ended December 31, 2022, impairment charges of $39.5 million were recorded for held and used properties, $0.2 million for held for sale properties, and $26.7 million for disposed properties.
For the Company’s impairment tests for the real estate assets during the year ended December 31, 2021, the fair value measurement for all 10 impaired properties was determined by applying an estimated sales price based on market data. During the year ended December 31, 2021, impairment charges of $49.9 million were recorded for held and used properties, and no impairment charges were recorded for held for sale properties or disposed properties.
The following tables present certain of the Company’s assets measured at fair value on a non-recurring basis as of December 31, 2022 and 2021, aggregated by the level in the fair value hierarchy within which those assets fall (in thousands):
Level 1
Level 2 (1)
Level 3 (1)
Balance as of December 31, 2022
Assets of properties held and used $ —  $ 38,900  $ 11,957  $ 50,857 
Assets of properties held for sale —  2,502  —  2,502 
$ —  $ 41,402  $ 11,957  $ 53,359 
Level 1
Level 2 (1)
Level 3 (1)
Balance as of December 31, 2021
Assets of properties held and used $ —  $ —  $ 59,339  $ 59,339 
Assets of properties held for sale —  —  —  — 
$ —  $ —  $ 59,339  $ 59,339 
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(1)The fair value of the level 2 category was derived using negotiated sales prices and the fair value of the level 3 category was derived using discounted cash flow analysis and management estimates of selling prices.
Fair Value of Financial Instruments
The fair value of short-term financial instruments such as cash and cash equivalents, restricted cash, accounts receivable, and accounts payable approximate their carrying value in the accompanying consolidated balance sheets due to their short-term nature. The fair values of the Company’s long-term financial instruments are reported below (dollars in thousands):
Level
Carrying Value at December 31, 2022
Fair Value at December 31, 2022
Carrying Value at December 31, 2021
Fair Value at December 31, 2021
Liabilities (1):
Bridge facility 2 —  —  $ 355,000  $ 355,000 
Mortgages payable 2 355,000  332,323  —  — 
Credit facility term loan 2 175,000  175,000  175,000  175,000 
Credit facility revolver (2)
2 —  —  90,000  90,000 
Total $ 530,000  $ 507,323  $ 620,000  $ 620,000 
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(1)Current and prior period liabilities’ carrying and fair values exclude net deferred financing costs.
(2)As of December 31, 2022, the Company did not have any amounts outstanding under its $425.0 million Revolving Facility.
Debt – The fair value is estimated by an independent third party using a discounted cash flow analysis, based on management’s estimates of credit spreads and observable market interest rates, representing level 2 on the fair value hierarchy.